Breaking Strategic Inertia Tips From Two Leaders

7/30/2019 Breaking Strategic Inertia Tips From Two Leaders

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Andreas C. KramvisPresident and CEO

Honeywell Performance

Materials and Technologies

Breaking strategic inertia: Tips from two leaders

Frameworks abound for developing corporate

strategy. But there’s no textbook or theory

that explains how to deliver on that strategy by

shifting capital, talent, and other scarce

resources from one part of a business to another.

One reason is that the moves each organiza-

tion must make at any point in time are unique.

Another is that different senior executives

have different roles to play. But that’s not to say

companies can’t learn from one another—in

fact, understanding the broad range of reallocation

challenges faced by different executives sheds

valuable light on common pitfalls and the decision-

making processes for sidestepping them.

Featured here are perspectives from two different

industries and corners of the C-suite. Guy Elliott,

the CFO of Rio Tinto, one of the world’s biggest

mining companies, discusses how it decides when

and how to place its bets. And Andreas Kramvis,

who heads Honeywell Performance Materials and

Technologies, provides insight from a business

unit perspective and outlines his novel approach tobringing strategy and resources into alignment.

Guy Elliott

CFO

Rio Tinto

A P R I L 2 0 1 2

s t r a t e g y p r a c t i c e



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Prioritizing projects and regions

We start from the proposition that we are not strategic capital allocators;

we are bottom-up capital allocators. We invest not by choosing the

commodity in which to put money but by choosing the project in which

to put money. For example, we observed that 80 percent of the money

in the copper world is made by 20 percent or less of the world’s copper

mines. Our objective is for all of our mines in all of our products to bein that 20 percent because we think we’re particularly good at running

large, long-life, low-cost mines.

Historically, we have not been particularly worried about which product

is “in,” because in the short to medium run, copper mines may do

better than nickel, or iron ore may do worse than aluminum. But

on a 50-year horizon, it’s much less clear that one metal is better than

another. It’s certainly true that one may have higher demand than

another, but what really matters is the difference between supply and

demand, and supply can often overshoot demand. The point of

departure for us has been bottom-up: geologically and infrastructure

driven. Is this deposit capable of being, over a long period, a low-cost,

expandable operation in its industry? If it is, let’s allocate capital to it.

There’s another dimension to this, beyond just looking at our port-

folio in project terms. You can also look at it as a jurisdiction portfolio.

For example, a very high percentage of assets in our portfolio—

approaching half—are in Australia, and about 40 percent are in North

Guy Elliott

has been the CFO of Rio Tinto—one of the world’s most diversified

mining companies, with operations on six continents and net assets

of roughly $60 billion—since 2002.



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America and Europe, mostly in Canada. And then we have about

10 percent in emerging markets. As we look for new opportunities,they’re mostly in emerging markets. So that 10 percent will enlarge over

time, but we need to think a bit more about the political risk and

the management challenge of emerging markets versus what we might

call “safer” jurisdictions.

Rebalancing the portfolio

In the middle of the last decade, we had a relatively diversified

portfolio. But we then started investing heavily in what looked to be

the most interesting business—iron ore, which had very high

margins that have since risen even more. We also made a very big

acquisition in aluminum and, as a consequence, ended up with a

very lopsided portfolio: skewed toward iron ore in terms of profit and

toward aluminum in terms of investment of capital. That’s caused

the beta of the company to rise.

The portfolio bias toward iron ore has been very beneficial, of course.

But it has unnerved investors a bit because they can’t believe the

good times are going to continue forever. So we are beginning to ask

ourselves questions about whether we should take action to “correct”

that portfolio bias. And it’s very difficult. We could stop further invest-

ments in iron ore. But if we did that, we would be turning our back

on some of the highest-return, lowest-risk investments we can make. So

that looks like a perverse course of action. We also could sell someiron ore assets, but why would you sell some of your best businesses

unless you really were clever enough to know precisely when the

top of the cycle was? And even then, would you get the right price, given

present market conditions?

Related to this is an essential part of our strategy: we don’t like to hedge.

We think there are natural hedges within the portfolio. In simple

terms, when the iron ore price is high, the Australian dollar is high;

and when the iron ore price is low, the Australian dollar is low. Our

margins are protected to some extent by this natural hedge because

our costs are chiefly denominated in Australian dollars. However,

there is a new phenomenon that is of concern. As Europe struggles, the

currencies of countries such as Australia and Canada have become

safe havens and behave differently than they have in the past. So our

natural hedge may not be quite as secure as it used to be. The other



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imperfection of a nonhedging strategy is that from time to time, you

have to make decisions about building something or buying or sellingsomething, and that’s implicitly a hedging decision.

Of course, we can’t avoid it, because we need to replenish our growth

pipeline continuously, as well as winnow our portfolio. But we don’t

do it with great enthusiasm, because it involves market timing and, if

we could do that well, we wouldn’t bother running a mining business;

we’d just be a trading business. We did major acquisitions in 1989, 1995,

and 2000 that have created many, many billions of dollars in value.

But of course we didn’t buy everything at the bottom or sell everything

at the top. One major acquisition—Alcan, in 2007—was strategically

in line with what we were trying to do, since it was a low-cost, long-life,

expandable business. But it was at the top of a cycle, which turned

down immediately after we bought it. With the benefit of hindsight, we

paid far too much for it in an auction.

Ensuring investment discipline

We institute checks and balances to manage internal lobbying. We have

something called the Investment Committee, which approves sizable

investments of any kind and consists of the chief executive, me, the head

of technology and innovation, and the head of business services. In

other words, it does not contain any of the divisional heads. The plan is

that this committee has enough data to have a dispassionate discus-

sion about an investment. Independence is essential: if it’s lost, we’relost. Separation of powers is important. Is the committee completely

immune to lobbying and strong characters? Of course it isn’t. But the

discipline and the checks and balances are there.

In addition to that, we have two other disciplines. One of them is the

information the committee gets. This committee receives three pieces

of paper. We get the recommendation of the project proponent. Then

we have an evaluation group that does a critique of the commercial

and financial stuff, and a technical and environmental critique. We try

to take the passion out of the debate.

The second discipline is a postinvestment review. After a period of

some years, we go back to the original proposal and calculate what the

return has been, which original estimates were wrong, which chal-

lenge was underestimated, what came out better than expected. From



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numerous postinvestment reviews we learn what we tend to get

wrong and what we tend to get right. That’s an important disciplinein any capital-intensive company because otherwise you don’t learn

from your mistakes. For us it’s particularly important. We invest a few

billion dollars in year one, and that makes or breaks our returns on

that project for the next 50 years. The upfront decision is critical, since

there are endless people who in their enthusiasm say, “Well, there’s a

big strategic merit to this project that overrides the returns,” or “Don’t

worry about these risks—we must be big in Brazil,” or “We must be in

the nickel business,” or whatever it is.

Finally, our experience is that regular investments—as opposed to

one-offs—succeed better. That’s also true of divestments. It’s the same

principle as time–cost averaging. Successful investors don’t buy their

whole stake at once and sit on it. They move into it gradually and, when

they want to sell, move out of it gradually. In an ideal world, that’s

how I would like to invest, even though, of course, that’s not possible in

a big acquisition or disposal.

This commentary is based on an interview with Stephen Hall, a director

in McKinsey’s London office; and Dan Lovallo, a professor at the University

of Sydney Business School, a senior research fellow at the Institute

for Business Innovation at the University of California, Berkeley, and an

adviser to McKinsey.



6

Resource allocation at the business

unit level

When you are in a business unit, you are much closer to your markets

than the corporate entity is. Your knowledge of how to invest

should be much sharper as well. Through rapid reallocation of your

existing resources, you should be able to capitalize on opportunities

more quickly than if you needed to apply for funds through a corporate

capital process. The last thing you want to do is go hat in hand to

corporate asking for capital when your businesses are not running well.

What I emphasize to teams is that if a business performs well, it will

get all the capital it needs from the company, and then some. You

need to turn the problem on its head and say there really never is a

shortage of capital—there is a shortage of returns. If you achievehigh returns, money will chase you.

There are plenty of opportunities to reallocate resources and create

short-term opportunities to drive higher returns. You might have a plant

that is outdated or pockets of investment dollars in areas that are

no longer relevant. In one of my previous jobs, we had a very large plant

that was uncompetitive, but the company kept putting money into

it rather than pursuing the next technology. We stopped making those

investments and diverted those funds to the new technologies; in

a short period of time, we were able to supplant those operations with

Andreas C. Kramvis

is the president and CEO of Honeywell Performance Materials and

Technologies, which has recorded double-digit margin improvements

for each of the past six years. He is the author of Transforming

the Corporation: Running a Successful Business in the 21st Century

(Randolph Publishing, September 2011).



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a state-of-the-art plant that had better cycle times, less waste, lower

costs, and a greater ability to roll out innovative products. In other words,

we funded the new plant ourselves by using funds that were previously

being applied to areas without an upside.

Beyond capital

Most people think that reallocation only means the reallocation of

capital. Granted, this is important. At the same time, I also like to think

about the reallocation of people and mindshare. Believe it or not, the

latter type of reallocation has the biggest impact.

A company that fails to organize its people the right way is most likely

to require what you might call “hard reallocations,” such as divest-

ments or portfolio overhauls. Reorienting people is difficult, but that’s

what makes it so important to focus on. Moving your best managers,

researchers, salespeople, and so on from low-growth or failing busi-

nesses to areas with higher growth and profit potential can be one

of your most effective levers as a business leader.

Myriad issues stand in the way of achieving a dynamic reallocation. You

can throw the whole management book at this and it may not suffice.

Culture and organizational politics can stand in the way; so can sheer

inertia. Managers can be as slow to change as their organizations,

and misperceptions of what is important to them can linger for a long

time, despite strong evidence to the contrary. You could even have the

wrong business model in place, which means your processes are wrong

and your ability to make good decisions is seriously impaired.

Shifting resources one ‘decision week’

at a time

To ensure that your organization is constantly reallocating resources from

weak areas to promising ones, you need a systematic operating method.

Most companies have a rhythm of meetings and performance reviews but

spend much of their time looking in the rearview mirror: What was last

month’s performance? What was last year’s performance? I believe you

need to impose an operating mechanism that reallocates resources in real

time and that educates your organization and instills core capabilities.

One operating mechanism I’ve found helpful is something I call

“business decision week.” 1 We run BDW ten times a year, and we take

1 For more on business decision week, see chapter four in Andreas C. Kramvis, Transforming

the Corporation: Running a Successful Business in the 21st Century, New Orleans, Louisiana:

Randolph Publishing, September 2011; or visit TransformingTheCorporation.com.



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its name seriously: decisions are actually made on the spot in real

time. Attendance is mandatory for my direct-leadership team. Confi-

dentiality limits the number of people who can be in attendance

at some sessions, but for others there is no reason not to have a large

number of managers listen in. The discussions are lively, and

listening in can be a great learning opportunity.

I will not take a meeting outside BDW to discuss a project requiring

capital approvals. Similarly, I will not take a separate meeting

about resources for a new project involving research and development.

Having one-off meetings and decisions would waste a lot of time

and defeat the objective of this open system, in which all the key peoplemust be present and comment on the matter at hand.

Business decision week forces my leadership team to look out the

windshield. What are the biggest opportunities we should concentrate

on? What capabilities do we need in order to pursue them? Where

are our people wasting time, and where should they be spending more

time today? How about in six months? We try to place management

time and focus on areas where we can grow, rather than focusing onfirefighting and activities with low potential.

I often think of BDW as analogous to the processor of a computer:

the know-how it instills is the software. By building know-how,

business decision weeks grow increasingly productive, and they enhance

the organization’s ability to prepare for future challenges.

An example of how BDW helped my current business was in rethinking

the engineering processes to help us understand the costs and risks

involved in major capital projects. We started our discussions with a

desire to reach a common vocabulary and set of metrics, so that

each month, our business leaders could fully understand where our

engineering resources were being applied. With each passing month,

the discussion grew more sophisticated—we turned our attention toward

reallocation of these resources to achieve the most critical objectives

faster and discussion of which capabilities we will most need in the

future. Now we’re focusing our attention on the biggest projects: theconstruction of new plants around the world. This is a significant under-

taking, and one we would not have been prepared for without having

both the processor and the software of business decision week in place.

Copyright © 2012 McKinsey & Company. All rights reserved.

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